Why Raising the FHA Mortgage Insurance

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As Congress moves to consider the House and
Senate appropriations bills for the Departments of Housing and
Urban Development (HUD) and Veterans Affairs (VA), lawmakers will
have to consider provisions to raise the maximum mortgage amount
that can be backed by the Federal Housing Administration (FHA)
insurance fund. If ultimately enacted into law, these provisions
would expand the federal government's role even deeper into the
residential mortgage market, provide windfall profits to a select
group of mortgage financiers, undermine the viability of private
mortgage insurers, and expose the U.S. taxpayers to a costly
bailout for the already faltering FHA insurance fund.

Since early this year, the FHA has been
confronting much-higher-than-expected loan defaults and insurance
claims. According to budget data provided to Congress by HUD, the
FHA's 1997 property acquisitions through foreclosure were up 117
percent, or a staggering $2.3 billion, from initial projections.
The FHA further announced that it anticipated this higher rate of
foreclosure to continue, and that it was revising 1998 foreclosed
property acquisition estimates upward from an initial $1.9 billion
to almost $4 billion. The FHA's declining confidence in the quality
of its mortgage insurance portfolio has been justified by events.
In the first quarter of 1998, despite the booming economy and
rising employment throughout the United States, the FHA's
delinquency rate reached an all-time high of 8.35 percent, meaning
that nearly one in ten FHA borrowers were behind in their payments.
This compares with a default rate of just 2.91 percent on
conventional mortgages, the market on which the FHA seeks
congressional approval to encroach.

Apparently having learned little from the
devastating collapse of the savings and loan industry in the 1980s
and the subsequent scandals that revealed shoddy underwriting
standards in billions of dollars of mortgages, some Members of
Congress are proposing that the FHA be allowed to insure a greater
share of the market by moving into riskier, higher-valued
mortgages. They also are recommending that the FHA's minimum
down-payment requirement be reduced from its already inadequate
levels. Minimal down-payment requirements under current law allow
the FHA to insure 99.6 percent of a $100,000 loan, leaving little
or no equity cushion to protect FHA reserves in the event of loan
default and/or foreclosure.

HUD
Secretary Andrew Cuomo has proposed that the FHA maximum loan limit
be increased to $227,150 throughout the country, and that FHA's
already generous down-payment requirements be made even more
generous. House and Senate appropriators have agreed to propose
much of what Cuomo is asking for: upping the regional cap on the
minimum loan from $86,000 to $109,000, raising the maximum cap from
$170,000 to $197,000, and allowing borrowers to make an even
smaller down payment.

If
enacted into law, these changes would worsen an already
deteriorating situation within the FHA's insured portfolio by
exposing it to disproportionately greater risks. With FHA
out-of-pocket losses typically running at a rate equivalent to 30
percent of the value of the loan on the foreclosed property, the
unanticipated foreclosed property acquisitions in 1997 and 1998
could lead to additional losses of $1.26 billion against the FHA's
reserves.

Rather than placing the taxpayer at far
greater risk of having to pick up the tab on foreclosed FHA-backed
mortgages, a better alternative for Congress to consider is an
amendment to the Senate bill that will be offered by a bipartisan
coalition composed of Senators Don Nickles (R-OK), Herbert Kohl
(D-WI), Connie Mack (R-FL), Wayne Allard (R-CO), and Russell
Feingold (D-WI). Their amendment would raise the floor on the
maximum-size mortgage the FHA can insure from the current $86,000
to $109,000 to target first-time and moderate-income home buyers
more accurately while also eliminating much of the windfall
corporate welfare benefits FHA mortgages bestow on some mortgage
financiers. Whereas conventional mortgages allow mortgage
originators to keep just 20 to 25 basis points in servicing fees,
the FHA currently allows them 44 basis points, which largely
explains the real estate industry's enthusiasm for the further
federalization of the market. Under the bipartisan coalition's
plan, these excessive servicing fees would be cut back to 38 basis
points, with the 6-basis-point difference applied to the Government
National Mortgage Association, a part of HUD that repackages and
reinsures FHA and VA mortgages for final sale to investors.

Although the bipartisan coalition's
amendment is a step in the right direction, an even better
alternative would be for Congress to reject any expansion of the
FHA's scope and instead hold oversight hearings to determine the
reason the FHA and the mortgage originators that use the program
have done such a consistently poor job of maintaining the financial
integrity of a program that could be of considerable value to
first-time home buyers. By failing to achieve underwriting
standards common in the conventional mortgage market, the existing
management of the FHA has exposed the U.S. taxpayer to the risk of
a costly bailout and made it likely that many more FHA home buyers
will face the humiliation and financial loss of foreclosure.